Deck 20: Management Compensation, Business Analysis, and Business

Question 1

Identify and explain the three objectives of management compensation.

Answer 1

Business analysis Valuation and Management Compensation.
Analysing the firm's future value is a critical task as prediction is depend on the future economic benefit can be generated. Firms value is important as many decisions are depend on firms computed value as it defines perception towards firm.Compensation to business manager is a important and critical task, as effective retaining of the them is essential for firm's success. Compensation involves salary, bonus, and benefits.
Discussion and analysis:
Three objectives of management compensation are:
1. Managers are motivated to achieve firm goal by paying them the appropriate compensation.
2. Freedom to make autonomous decision that are in accordance to the firm's goal, and providing incentives.
3. Efforts and skills of the managers should be duly recognised and rewarded for effective decision making.

Question 2

Tinsley Inc. is an industry-leading cardboard manufacturer. You have been asked to determine a market value for the firm's equity. The firm has 100,000 shares outstanding, earnings per share of $2.50 last year, and a stock price of $25. What is the market value

Answer 2

Firm's market value is determined by multiplying current share price into the number of share outstanding. This market value provide clear picture of equity at the market and which indicates the current value of the company. It is known as firm's market capitalization.
Market value of the share indicates the value of company as if share value increase value of the firm also goes up, and if the value decline of the share it clearly indicates that there is something wrong and the management must take comprehensive action to increase the share value by providing good quality in the product at the least cost and also satisfied the customer at any cost to boost the sale of the product.
Market value of equity is determined by multiplying current share value to the number of share outstanding.
Hence, the market value of the equity is
Here, market value of the equity is $2,500,000. As firm grows its market value increases which is a good indicator. And every company take efforts to boost the market value of the equity which result to increase the market value of the firm.

Question 3

Business Valuation Refer to the information in Exercise 20-32.
Required Develop a business valuation for Williams Company for 2013 using the following methods: (1) book value of equity, (2) market value of equity, (3) discounted cash flow (DCF), (4) enterprise value, and (5) all the multiples-based valuations for which there is an industry average multiplier. For the calculation of the DCF valuation, you may use the simplifying assumption that free cash flows will continue indefinitely at the amount in 2013.
Reference:
Business Analysis Williams Company is a manufacturer of auto parts having the following financial statements for 2012-2013.

Required Calculate and interpret the financial ratios (per Exhibit 20.9 ) for Williams for 2012 and 2013. Since the calculation of many ratios requires the average balance in an account (e.g., average receivables is required in calculating receivables turnover), you may assume that the balances in these accounts in 2012 are the same as those in 2011.

Answer 3

Business Valuation is a technique that which is used to evaluate the performance of business by using the financial techniques.Here we are asked to evaluate the business of "WC and Co.," by using the five business valuation techniques for the year 2013.
1) Business Valuation by using the book value equity method:
From the given balance sheet it was clear that the book value of equity which can otherwise also be known as book value of share holder for the equity for the year 2013 is $1,335,000.
2) Business Valuation by using the market value of the equity method:
In this instance we are asked to evaluate the business on the basis of market value for the equity of the business. The general formula to evaluate the business under market value of equity method is,
In the provided data under additional financial information it was mentioned that the number of outstanding shares were 1,800,000 and the year end stock price is $2.25 for the year 2013.With the substitution of given data in the above formula as per the relevance we get the market value of equity as,
3) Business Valuation by using Discounted Cash Flow (DCF) Method :
In this instance we are asked to evaluate the business by using discounted cash flow technique under the assumption that the free cash flows would continue indefinitely at the amount in 2013.Hence first we need to get the free cash flows value and next the present value of cash flows by using the discounted free cash flows.
Step I: Calculation of Free Cash Flows
The value of free cash flow is determined by subtracting the capital expenditures and dividends from the cash flow from operations value. Hence the value of free cash flows would be,
From the above table it was clear that the free cash flow for the year 2013 till infinity would be $25,000.hence the present value under the discounted cash flow technique would be calculated upon the free cash flow determined at the rate of 5% which was given as cost of capital.
Step II: Calculation of present value on the basis of Discounted Cash Flow (DCF)
In the instance of free cash flow value being same till the infinity the free cash flow would be multiplied with the inverse if cost of capital to get the present value of cash flows. The formula that is applied in this instance is,
With the substitution of evaluated values in the above formula we get the present value of cash flows as,
Therefore the discounted free cash flows would be $500,000
4) Business Valuation by using the Enterprise Value Method:
In this instance we are asked to evaluate the business on the basis of enterprise value of the business. The general formula to evaluate the business by using the enterprise value method is,
Here the market capitalization means nothing but the market value of equity which is the product of number of outstanding shares and year end stock price which we have evaluated as $4,050,000.The values of cash and debt as per the data given in balance sheet were $260,000 and $900,000 respectively. Hence by substituting all the data in the above formula we get the enterprise value as,
5) Business Valuation by using the Multiple Based Valuation:
In this instance we are asked to evaluate the business on the basis of the three multiples which are earnings multiple, free cash flow multiple, and sales multiple. These multiples would be multiplied with the relevant factors and the product would be the value on the basis of each valuation.
Calculation of Multiple based valuation by using earnings multiplier:
The formula to evaluate the multiple based valuations by using earning multiplier is,
Here in the financial information that which is provided it was mentioned that the earnings multiplier is 9.00 and Earnings for the year 2013 are $325,000.
With the substitution of given data in the above formula as per relevance we get the value of business under earnings multiple valuation as,
Therefore the value on the basis of earnings multiple valuation is $2,925,000.
Calculation of multiple based valuations by using the free cash flow multiple:
The formula to evaluate the multiple based valuations by using free cash flow multiplier is,
Here as per the data provided and evaluated the free cash flow multiplier is 18.00 and the free cash flows for the year 2013 are $25,000.With the substitution of these data in the above data as per the relevance we get the free cash flow multiple value as,
Therefore the value on the basis of free cash flow multiple valuation is $450,000.
Calculation of multiple based valuations by using the sales multiple:
The formula to evaluate the multiple based valuations by using sales multiplier is,
In the provided data it was mentioned that the sales multiplier is 1.50 and the value of sales is $3,500,000 for the year 2013.With the substitution of the given values in the above formula we get the value of business by using sales multiplier as,
Therefore the value on the basis of sales multiplier valuation is $5,250,000.
The value of business from all the valuations has ranged in between the $1,335,000 to $5,250,000 indicating a significant range. Though the wide range of difference in values is not unusual it is due to the application of methods. However for the next start of analysis the median of all these values would be used.

Question 4

Business Analysis and Business Valuation JJP Autoparts, Inc., a manufacturer of auto parts, experienced a decline in earnings in the recent year and has consulted its accounting firm for an analysis of the firm's financial statements. Additionally, the company knows that its market value has fallen from the prior year, since the share price has fallen from $5.50 at the end of 2012 to $2.34 at the end of 2013. So, JJP also want an analysis of the firm's change in value. The comparative balance sheet and income statement for 2013 follow:

Additional relevant information about JJP is that it uses a cost of capital rate of 5.7%. Also it incurred capital expenditures of $100,000 in 2012 and $50,000 in 2013; there were no cash dividends in either year. The number of outstanding shares is 653,554, the same in both years.
Industry data, the average values for firms in the autoparts industry, follow:

Required:
1. Calculate and interpret the liquidity, cash flow, and profitability ratios for JJP for 2012 and 2013. In your calculations, you may assume that the balance sheet values for 2012 are the same as for the prior year, 2011
2. Develop and interpret a business valuation for JJP for 2012 and 2013 using the methods you think appropriate.

Question 5

Explain the three types of management compensation.

Question 6

Jamison Auto Parts produces replacement parts for automobiles. Last year Jamison had EVA ® net income of $200,000, cost of capital of 10 percent, and EVA® capital of $750,000. Determine the firm's economic value added.

Question 7

Business Valuation Five different analysts have submitted valuations for a private technology firm that is the subject of a possible acquisition. The valuations are as follows:
Required The value of having multiple analyst reports is that one can develop a range of possible valuations, and select a final valuation that seems appropriate. What valuation would you choose for this technology company Explain your reasoning.

Question 8

Research Assignment; Business Valuation Read the following article by Joel Litman and Mark L. Frigo, "When Strategy and Valuation Meet," Strategic Finance, August 2004, pp. 31-39. The article provides a comprehensive discussion of how business strategy and business valuation are interrelated and provides five lessons based on an understanding of this interrelationship.
The article is available in the Cases and Readings Supplement that comes with the text or it may be accessed using the link found on the text website.
Required
1. Explain briefly the different skills required by a business strategy expert and a business valuation expert.
2. Explain why a great product seldom ensures a great business.
3. Explain why being "different" is not central to strategy.
4. Explain the difference between a great company and a great stock.
5. Explain when and why growth is not necessarily a good thing.

Question 9

Explain how a manager's risk aversion can affect decision making and how compensation plans should be designed to deal with risk aversion.

Question 10

Moore Heel is a shoe manufacturing company. Moore has hired you to value the company based on the discounted cash flow method. You have determined that the present value of the company's cash flows is $400,000, marketable securities total $150,000, and the market value of debt is $250,000. What is the value of the firm

Question 11

Compensation; Net Present Value Glee Candy Co. makes chewy chocolate candies at a plant in Winston-Salem, North Carolina. Brian Bishop, the production manager at this facility, installed a packaging machine last year at a cost of $400,000. This machine is expected to last for 10 more years with no residual value. Operating costs for the projected levels of production are $95,000 annually.
Brian has just learned of a new packaging machine that would work much more efficiently in Glee's production line. This machine would cost $520,000 installed, but the annual operating costs would be only $30,000. This machine would be depreciated over 10 years with no residual value. He could sell the current packaging machine this year for $180,000.
Brian has worked for Glee for seven years. He plans to remain with the firm for about two more years, when he expects to become a vice president of operations at his father-in-law's company. Glee pays Brian a fixed salary with an annual bonus of 5% of net income for the year.
Assume that Glee uses straight-line depreciation and has a 10% required rate of return. Ignore income-tax effects.
Required
1. As the owner of Glee, would you want Brian to keep the current machine or purchase the new one
2. Why might Brian not prefer to make the decision that the owner of Glee desires

Question 12

Explain how management compensation can provide an incentive to unethical behavior. What methods can be used to reduce the chance of unethical activities resulting from compensation plans

Question 13

Smith Co. is a firm specializing in financial advice for retired individuals. After some analysis, you have determined that an earnings multiplier of 7 is appropriate for this type of business. Smith's most recent earnings totaled $250,000. What is the value of the firm based on the earnings multiplier

Question 14

Compensation; Benefits; Ethics DuMelon Publishing Inc. is a nationwide company headquartered in Boston, Massachusetts. The firm's benefits are a significant element of employee compensation. All professional employees at DuMelon receive company-paid benefits including medical insurance, term life insurance, and paid vacations and holidays. They also receive a set reimbursement amount of $250 per day maximum for travel expenses when they conduct business for DuMelon. DuMelon offers a 25 percent match for money the professionals deposit in the company-sponsored 401(k) plan.
These benefits vary, depending on the employee's salary and level in the company. For example, the amount of vacation days increases as a professional is promoted to higher levels. The maximum amount that can be contributed to the 401(k) plan also increases as the employee's salary increases, subject to an overall limitation provided by tax laws.
When a DuMelon employee attains the position of vice president of a function, such as operations or sales, that person qualifies for a special class of additional benefits: a company car, a larger office with decoration allowances, and access to the executive suite at the Boston office. (The executive suite features a dining room and lounge for the executives' use.) The perks also include total reimbursement for all business travel expenses.
Required
1. Explain the implications for employee behavior and performance of DuMelon's two levels of benefits for professional employees, including ethical issues.
2. Suppose that the policy for benefits is not applied strictly at DuMelon. As a result, the following instances have occurred:
a. The company has occasionally paid the travel expenses of VPs' spouses. Company policy is unclear as to whether this is allowed.
b. Some VPs have special-ordered their company-provided vehicles, which on average costs the company an additional $23,000 for each car.
c. Passes to the executive suite have been lent to other DuMelon professionals.
d. Some of the vice presidents have offices that are much larger than those of other vice presidents. No apparent factors determine who gets the larger offices.
How might this situation affect the behavior of vice presidents and other professionals at DuMelon What are the underlying implications for cost control of benefits Use specific examples when applicable.

Question 15

From a financial reporting standpoint, what form of compensation is most desirable for the firm

Question 16

Johnson Healthcare is a health-care firm specializing in products for the disabled. Johnson plans to maintain a 10 percent gross profit margin. After analyzing last year's data, you found that Johnson had gross profit of $250,000 and net sales of $1,500,000. What was the gross profit margin, and by what percentage did the firm achieve its goal

Question 17

Incentive Pay in The Hotel Industry Ramon Martinez is the general manager of Classic Inn, a local mid-priced hotel with 100 rooms. His job objectives include providing resourceful and friendly service to the hotel's guests, maintaining an 80 percent occupancy rate, improving the average rate received per room to $88 from the current $85, and achieving a savings of 5 percent on all hotel costs. The hotel's owner, a partnership of seven people who own several hotels in the region, want to structure Ramon's future compensation to objectively reward him for achieving these goals. In the past, he has been paid an annual salary of $72,000 with no incentive pay. The incentive plan the partners developed has each of the goals weighted as follows:
If Ramon achieves all of these goals, the partners determined that his performance should merit a bonus of $23,000. The partners also agreed that his salary would be reduced to $60,000 because of the addition of the bonus.
The goal measures used to compensate Ramon are as follows:
Ramon's new compensation plan will thus pay him a $60,000 salary plus 31.5 cents per room- night sold plus $1,150 for each percentage point saved in the expense budget plus $26.83 per each cent increase in average room rate.
Required
1. Based on this plan, what will Ramon's total compensation be if his performance results are
a. 30,000 room-nights, 5 percent saved, $3.00 rate increase
b. 25,000 room-nights, 3 percent saved, $1.15 rate increase
c. 28,000 room-nights, 0 saved, $1.00 rate increase
2. Comment on the expected effectiveness of this plan.

Question 18

From a tax-planning standpoint, what form of compensation is least desirable for the manager For the firm

Question 19

C ompensation, Strategy, and Market Value Jackson Supply Company is a publicly owned firm that serves the medical supply needs of hospitals and large medical practices in six southeastern states. The firm has grown significantly in recent years, as the areas it serves have grown. Jackson has focused on customer service and has developed an excellent reputation for speed of delivery and overall quality of service. The company ensures that customer service is each manager's main focus by making it count for 50 percent of the management bonus. The firm measures specific indicators of customer service monthly; progress toward these measures as well as others is used to determine each manager's bonus. In the past several months, top management has noticed that although most managers are meeting or exceeding their customer service goals and receiving bonuses accordingly, the firm's stock price has been lagging while competitive firms' stock prices have been rising steadily.
Required What modification, if any, should Jackson Supply Company make to its management compensation plan

Question 20

Incentive Pay Formula Development Use the concepts in problem 20-38 to complete the following requirements.
Required
1. Design an incentive pay plan for a restaurant manager whose goals are to serve 300 customers per day at an average price per customer of $6.88. The restaurant is open 365 days per year. These two goals are equally important. The incentive pay should be $12,800 if the manager achieves all goals. Assume the manager's salary is $68,000.
2. Calculate the manager's total compensation if the restaurant serves 280 customers per day at an average price of $6.75.

Question 21

List the three bases for bonus incentive plans; explain how they differ and how each achieves or does not achieve the three objectives of management compensation.

Question 22

Evaluating an Incentive Pay Plan; Strategy Anne-Marie Fox is the manager of a new and used boat dealership. She has decided to reevaluate the compensation plan offered to her sales representatives to determine whether the plan encourages the dealership's success. The representatives are paid no salary, but they receive 20 percent of the sales price of every boat sold, and they have the authority to negotiate the boats' prices as far down as their wholesale cost if necessary.
Required Is this plan in the dealership's strategic best interest Why or why not

Question 23

Compensation Pools; Residual Income; Review of Chapter 19 Wilson Brands Inc. (WBI) is a retailer of consumer products. The company made two acquisitions in previous years to diversify its product lines. In 2011, WBI acquired a consumer electronics firm producing computers. WBI now (2013) has three divisions: consumer electronics, office supplies, and computers. The following information (in thousands) presents operating revenue, operating income, and invested assets of the company over the last three years.

The current compensation package is an annual bonus award. Senior executives share in the bonus pool, which is calculated as 10% of the company's annual residual income. Residual income is defined as operating income minus an interest charge of 6% of invested assets.
Required
1. Use asset turnover, return on sales, and return on investment (ROI) to explain the differences in profitability of the three divisions.
2. Compute the bonus amount to be paid during each year; also compute individual executive bonus amounts.
3. If the bonuses were calculated by divisional residual income, what would the individual bonus amounts be
4. Discuss the advantages and disadvantages of basing the bonus on WBI's residual income compared to divisional residual income.

Question 24

Identify and explain the six financial ratios used to evaluate liquidity as part of the firm's business analysis.

Question 25

Alternative Compensation Plans ADM, Inc., an electronics manufacturer, uses growth in earnings per share (EPS) as a guideline for evaluating executive performance. ADM executives receive a bonus of $5,000 for every penny increase in EPS for the year. This bonus is paid in addition to fixed salaries ranging from $500,000 to $900,000 annually.
Cygnus Corporation, a computer components manufacturer, also uses EPS as an evaluation tool. Its executives receive a bonus equal to 40 percent of their salary for the year if the firm's EPS is in the top third of a list ranking the EPS for Cygnus and its 12 competitors.
Required
1. Why are companies such as ADM, Inc., and Cygnus Corporation switching from stock option incentives to programs more like the ones described What does the use of these plans by the two firms say about each firm's competitive strategy
2. What are the weaknesses of incentive plans based on EPS

Question 26

Compensation; Strategic Issues Mobile Business Incorporated (MBI) is a worldwide manufacturing company that specializes in high technology products for the aerospace, automotive, and plastics industries. State-of-the-art technology and business innovation have been key to the firm's success over the last several years. MBI has 10 manufacturing plants in six foreign countries. Its products are sold worldwide through sales representatives and sales offices in 23 countries. Performance information from these plants and offices is received weekly and is summarized monthly at the Toronto headquarters.
The company's current bonus compensation package focuses on giving rewards based on the utilization of capital within the company (i.e., management of inventory, collection of receivables, and use of physical assets). The board of directors is concerned, however, with the short-term focus of this plan.
Some employees believe that the company's current compensation plan does not reflect its stated goals of maintaining and enhancing its global position through innovative products.
Required Develop a bonus package that considers MBI's strategic goals and the global environment in which it operates.

Question 27

What are the two types of bonus pools for bonus incentive plans How do they differ, and how does each achieve or not achieve the three objectives of management compensation

Question 28

Performance Evaluation and Risk Aversion Jill Lewis is the office manager of PureBreds, Inc. Her office has 30 employees whose collective job is to process applications by dog owners who want to register their pets with the firm. There is never a shortage of applications waiting to be processed, but random events beyond Lewis's control (e.g., employees out sick) cause fluctuations in the number of applications that her office can process. Jill is aware that it is important that the applications be processed quickly and accurately.
Alex Zale, the district manager to whom Jill reports, bases his evaluation of Jill on the number of applications that are processed.
Required
1. If Jill is risk-averse, how should Alex compensate her Why
2. What is a disadvantage of an evaluation method that is based only on the number of processed applications
3. List at least two ways that Alex could measure how accurately Jill's office is processing the applications.

Question 29

Executive Compensation; Teams; Strategy; Ethics Universal Air Inc. supplies instrumentation components to airplane manufacturers. Although only a few competitors are in this market, the competition is fierce.
Universal uses a traditional performance incentive plan to award middle-management bonuses on the basis of divisional profit. Recently, Charles Gross, chief executive officer, concluded that these objectives might be better served with new performance measures. On January 1, 2013, he assigned his executive team of top-level managers to develop these new measures.
The executive team conducted a customer survey. Although Universal has always prided itself on being on the technological forefront, the survey results indicated technology to be a low priority for customers, who were more concerned with product quality and customer service. As a result, the executive team developed 30 new criteria to measure middle-management performance and directed the controller to develop the necessary monthly reports and graphs to report on these new measures. Then the executive team announced to middle managers that these new indicators would be used to evaluate their performance. The managers were not enthusiastic and complained that some measures were influenced by the performance of other departments that they could not control. Over the next few months, customer complaints increased, and a major customer chose a competitor over Universal.
Upon seeing these results, Charles decided to review the new process. In a meeting with executive and middle managers, he emphasized that the new measures should help balance the company's performance between increased customer value and improved operating process efficiency. He set up two cross-functional teams of executives and middle managers to develop a second set of new measures: one to evaluate new product development and the other to evaluate the customer order and fulfillment process. Both teams are to focus on cost, quality, and scheduling time.
Richard Strong, quality inspection manager, is the brother-in-law of John Brogan, cost accounting manager. On June 1, John telephoned Sara Wiley, the purchasing manager at Magic Aircraft Manufacturing Inc., one of Universal's major customers. Brogan said, "Listen Sara, we're jumping through all these hoops over here to measure performance, and management seems to be changing the measures every day. It was so easy before, getting a bonus based on the bottom line; now we have to worry about things out of our control based on how the customer perceives our performance. Would you do me a favor If you have any complaints, please have your people call me directly so I can forward the complaint to the right person. All that really matters is for all of us to make money." In actuality, Richard was the only person to whom John reported the customer complaints that Sara offered.
Required
1. For Universal Air Inc. to remain competitive, should it implement the second set of new performance measures Identify for the company:
a. At least three customer value-added measures.
b. At least three process-efficiency measures.
2. Identify at least three types of employee behaviors that Universal can expect by having middle management participate in the development of the second set of new performance measures.
3. Describe what executive management at Universal should do to ensure the effectiveness of the cross-functional teams.
4. Referring to the specific standards for ethical conduct by a management accountant (Chapter 1), consider whether John Brogan's behavior is unethical.

Question 30

List the four types of bonus payment options and explain how they differ. How does each achieve or not achieve the three objectives of management compensation

Question 31

Performance Evaluation and Risk Aversion Heartwood Furniture Corporation has a line of sofas marketed under the name NightTime Sleepers. Heartwood management is considering several compensation packages for Amy Johnson, NightTime's general manager. Amy's duties include making all investing and operating decisions for NightTime.
Required
1. Amy is risk-neutral and prefers to receive the maximum reward for her hard work. Do you recommend compensation based on flat salary, an ROI-based bonus, or a combination of both Why
2. If Amy does not make investing decisions for NightTime, is ROI still a good performance measure If so, then explain why. If not, suggest an alternative.
3. Heartwood Furniture plans to evaluate Amy by comparing NightTime's ROI to the ROI of Stiles Furniture, which operates in a business environment similar to that of NightTime. Both companies have the same capabilities, but Stiles uses a significantly different manufacturing strategy than NightTime.
a. Would evaluating Amy with this benchmark be fair
b. Would using residual income instead of ROI offer any advantages for Heartwood

Question 32

Executive Compensation Jensen Corporation is a holding company with several diversified divisions operating throughout the United States. Jensen's management allows the divisions to operate on an autonomous basis in most areas; however, the corporate office becomes involved in determining some division strategies related to capital budgeting, development of marketing campaigns, and implementation of incentive plans. The area of incentive plans has often been a problem to Jensen because many of the companies it has acquired already had such plans in place. These plans are not easily changed without causing discontent among the managers. Jensen has striven for consistency among its divisions with regard to bonus and incentive plans, but this has not always been achievable.
The restaurant division operates a chain of vegetarian restaurants, Hobbit Hole, in the eastern United States. Jensen acquired it approximately three years ago and has made very few changes to it. The restaurant's reputation was well established and, aside from nominal changes in marketing strategy, the chain has been allowed to operate in much the same manner as it did before its acquisition. In addition to a base salary, Hobbit Hole unit managers participate in the restaurant's profits. This incentive plan was in place when Jensen acquired the chain; although the profit percentage might vary among restaurant units, the overall plans are basically the same. The unit managers are satisfied with this incentive strategy, and Jensen's management does not believe that changes are necessary.
Jensen's motel division was formed 15 years ago when Jensen purchased a small group of motels in the Midwest. Since that time, the division has grown significantly as the company has acquired motels throughout the country using the name Cruise and Snooze Inns. Since its initial motel purchase, Jensen has implemented its own incentive program for unit managers in the individual motels. The incentive program provides annual bonuses based on the achievement of specific goals that are not necessarily finance oriented but pertain to areas such as improved quality control and customer service. This program requires administrative time, but Jensen believes that the results have been satisfactory.
Required
1. Hobbit Hole's restaurant unit managers are covered by a profit participation incentive plan. Discuss the following for this incentive plan:
a. Its benefits to Jensen Corporation.
b. The incentive effects that it could cause, if any.
2. The Cruise and Snooze Inns' motel unit managers participate in an incentive program based on goal attainment. Discuss the following for this type of incentive plan:
a. Advantages to Jensen Corporation.
b. Disadvantages to Jensen Corporation.
3. Having two different types of incentive plans for two operating divisions of the same company raises questions.
a. Describe the potential negative incentive effects of having different types of incentive plans for Hobbit Hole and Cruise and Snooze Inns.
b. Present the rationale that Jensen Corporation can give to the unit managers of Hobbit Hole and Cruise and Snooze Inns to justify having different incentive plans for two operating divisions of the same company.

Question 33

Develop arguments to support your view as to whether executive pay in the United States is too high.

Question 34

Bonus Compensation Base and Pool There are three components to a bonus plan: the base of the bonus compensation (earnings, revenues), the bonus pool (firmwide or unit-based), and the payment options (cash, stock options). It is common in many industries, including the financial services industry, to use a firmwide pool and revenue as the base for bonus compensation.
Required
1. What are some alternative bases for compensation pools, in addition to revenue
2. What effect do you expect the use of revenues, rather than some other base, to have on both the motivation of managers and the total bonuses paid to managers Comment on the effectiveness of the revenue base relative to other options for the bonus compensation base.
3. Explain the likely motivational effects of the use of the firmwide bonus plan for firms in the financial services industry.
4. Do you consider the firmwide revenue plan for bonus compensation to be a fair method for determining bonuses Why or why not

Question 35

Compensation; Regression Analysis; Spreadsheet Application Many people ask, "Are executives worth their very high pay" As noted in the chapter, this is a difficult question to answer because the benefits an effective executive brings to the company are hard to measure. One thing we can do, however, is to see if changes in executive pay are correlated with changes in company performance. If pay increases when company performance increases, and vice versa, then this would be an indication that pay practices are aligned with the interests of shareholders. To study this question, we have data (from The New York Times, April 10, 2011) for the 30 highest paid chief executive officers (CEOs) in the United States. The data below include 29 of these 30 CEOs (because he was a new CEO in 2010, the change in compensation could not be determined for the fourth-ranked CEO, Michael D. White of DirecTV; therefore, he is not included):

In the above table, the change in compensation is measured as the percentage change in total compensation from 2009 to 2010; total return (our measure of company performance) is measured by the percentage change in stock price plus dividends.
Required Using regression and/or correlation analysis, examine the above data and determine whether there is a significant relationship between the change in compensation for these executives and the change in the company's performance. That is, from your analysis, does it appear that the CEOs' pay is aligned with shareholder interests Comment briefly on your findings.

Question 36

Explain the different business valuation methods. Which do you think is superior and why

Question 37

Compensation and Trust Bill George, a Harvard Business School professor, notes the increasing lack of trust many now have for the executive compensation plans in place in many corporations. Writing in Bloomberg Businessweek (September 13, 2010, p. 56) , he suggests six policies which, if followed by regulators and the compensation committees on corporate boards, would rebuild trust in corporate pay policies:
1. Provide full transparency for compensation policies and actual practices.
2. Create policies that reward long-term performance.
3. Reward executives for their performance, not the company's stock price.
4. Lengthen the time horizon for bonuses.
5. Use approaches that include qualitative measures like strategy implementation, research milestones, and leadership development.
6. Boost fairness between executives and workers.
Required
1. Which of George's suggestions do you think are critical to rebuilding shareholders' and others' trust in corporate compensation policies Explain briefly.
2. Can you think of another suggestion for improving shareholders' trust in corporate executive pay policies and practices Explain your choice(s) briefly.

Question 38

Executive Compensation; Regression Analysis A recent study of the airline industry examined whether a performance for a selected nonfinancial measure was a significant predictor of CEO compensation. A sample of 35 firms was taken and regression obtained to determine the potential relationship between selected financial and nonfinancial independent variables and three dependent variables: (a) CEO cash compensation, (b) CEO compensation in the form of options granted during the year, and (c) total CEO compensation (a + b).
The independent variables were:
• Passenger load (PL), the proportion of seats filled to the seats available.
• Stock price return (RT), the increase in stock price plus dividends over the year relative to beginning of year.
• Return on assets (ROA), income over total assets.
• Sales.
• Stock price volatility (V), the standard deviation of daily stock price changes in the company's stock price.
• CEO ownership (CEO), the percentage of the company's outstanding shares owned by the CEO.
• CEO tenure(CEO-T), the number of years the CEO has been on thejob.
• Ratio ofbook value of the company to the market value of the company (BM), a measure of the market value of the company.
The table below shows the three dependent variables, the eight independent variables, and the significance (p-value) of the independent variable in each equation. For example, in the regression with the dependent variable, cash compensation (Regression One), the PL variable is significant at the.01 level, RT is significant at the.01 level, and the ROA variable is not significant. The authors of the study hypothesized that there would be a positive significant relationship between CEO compensation and the one nonfinancial variable, passenger load.
* Dependent variables were transformed using the natural logarithm.
† This variable had a significant negative coefficient, indicating an inverse relationship with the dependent variable.
Required Review the three regressions above and develop a brief explanation for each of the following:
1. Which of the three regressions would you most rely on, and why
2. What do the regression results tell you about the relationships of the independent variables to the three dependent variables
3. Were the authors of the study correct about their expectation regarding the PL variable
4. How would you use this information in designing compensation plans for executives in the airline industry

Question 39

What type of management compensation is the fastest growing part of total compensation Why do you think this is the case

Question 40

Compensation at Nonpublic Companies The executive compensation programs of the largest public companies often include the types of equity-based compensation such as stock options and performance shares as described in this chapter. Smaller nonpublic companies often have the same types of strategic goals and want to provide the same types of compensation plans as do the larger public companies but do not have the equity types of compensation to offer since the firms do not have publicly-traded stock.
Required:
1. What are the advantages of equity-based compensation such as stock options and performance shares
2. What types of compensation can nonpublic companies offer that would provide the desired incentives that equity-based compensation offers

Question 41

Business Analysis; Spreadsheet Application Blue Water Yachts is a small company founded by two businesspeople who are friends and avid sailors. At present, they are interested in expanding the business and have asked you to review its financial statements.
Blue Water Yachts sells approximately 100 to 150 sailboats each year, ranging from 14-foot dinghies to 20-foot sailboats. Their sales prices range from $2,000 to more than $10,000. The company has a limited inventory of boats consisting primarily of one or two boats from each of the four manufacturers that supply Blue Water. The company also sells a variety of supplies and parts and performs different types of service. Most sales are on credit.
The company operates from a large building that has offices, storage, and sales for some of the smaller sailboats. The larger sailboats are kept in a fenced area adjacent to the main building, and an ample parking area is nearby. This year Blue Water purchased a boat lift to haul boats. The lift has brought in revenues for boat repairs, hull painting, and related services, as well as the boat hauls.
The balance sheet and income statement for Blue Water Yachts for 2008 through 2013 follow. The increase in net fixed assets in the recent two years is due to improvements in the building, paving of the parking area, and the purchase of the lift.
The company obtains its debt financing from two sources: a small savings and loan for its short-term funds, and a larger commercial bank, also for short-term loans, but principally for long-term financing. The terms of the loan agreement with the bank include a restriction that its current ratio must remain higher than 1.5.
Required Evaluate the liquidity and profitability of Blue Water Yachts using selected financial ratios. Assess the company's overall profitability, liquidity, and desirability as an investment. Use a spreadsheet to improve the speed and accuracy of your analysis.

Question 42

Why do you think it is important for a management accountant to be able to complete an evaluation of the firm separate from an evaluation of individual managers

Question 43

Compensation in Tough Economic Times During an economic recession companies are under pressure to reduce costs, and a significant part of total cost for most companies is salaries and wages, including both executive compensation and employee compensation.
Required Review the types of compensation we have covered in this chapter and explain which types of compensation you would reduce if needed to help a company through difficult economic times.

Question 44

Business Valuation Refer to the information in Problem 20-45 for the Blue Water Yachts Company.
Required Develop a business valuation for Blue Water Yachts Company for 2013 using the book value of equity method and the multiples-based method. Assume that the industry average earnings multiple is 8 and the industry average multiple on operating cash flow is 6. Which of the methods would you use and why
Reference:
Business Analysis; Spreadsheet Application Blue Water Yachts is a small company founded by two businesspeople who are friends and avid sailors. At present, they are interested in expanding the business and have asked you to review its financial statements.
Blue Water Yachts sells approximately 100 to 150 sailboats each year, ranging from 14-foot dinghies to 20-foot sailboats. Their sales prices range from $2,000 to more than $10,000. The company has a limited inventory of boats consisting primarily of one or two boats from each of the four manufacturers that supply Blue Water. The company also sells a variety of supplies and parts and performs different types of service. Most sales are on credit.
The company operates from a large building that has offices, storage, and sales for some of the smaller sailboats. The larger sailboats are kept in a fenced area adjacent to the main building, and an ample parking area is nearby. This year Blue Water purchased a boat lift to haul boats. The lift has brought in revenues for boat repairs, hull painting, and related services, as well as the boat hauls.
The balance sheet and income statement for Blue Water Yachts for 2008 through 2013 follow. The increase in net fixed assets in the recent two years is due to improvements in the building, paving of the parking area, and the purchase of the lift.
The company obtains its debt financing from two sources: a small savings and loan for its short-term funds, and a larger commercial bank, also for short-term loans, but principally for long-term financing. The terms of the loan agreement with the bank include a restriction that its current ratio must remain higher than 1.5.
Required Evaluate the liquidity and profitability of Blue Water Yachts using selected financial ratios. Assess the company's overall profitability, liquidity, and desirability as an investment. Use a spreadsheet to improve the speed and accuracy of your analysis.

Question 45

How does the firm's management compensation plan change over the life cycle of the firm's products

Question 46

International Accounting Standards and Bonus Compensation The International Accounting Standards Board ( www.IASB.org ) is a London-based independent organization that develops and interprets international financial reporting standards (IFRS). The mission of the IASB is to develop a single set of high quality, globally accepted accounting standards. As of April 2012, 123 countries throughout the world either permit or require IFRS for publicly held companies in their country. The U.S. continues to use generally accepted accounting principles (GAAP) as developed by the U.S.-based Financial Accounting Standards Board (FASB). The FASB, under the guidance of the SEC, has developed a plan in which the FASB and the IASB work together to complete a convergence of IFRS and GAAP. The timetable for convergence is not firmly set, but many believe it will be a matter of only a few years before U.S. firms will be using IFRS or something very much like it. Some of the notable differences between GAAP and IFRS are that IFRS does not permit LIFO valuation of inventory (GAAP does), and IFRS does permit market value treatment of certain long-lived assets (GAAP does not). Experts note that the move to IFRS will certainly affect U.S.-based firms in terms of corporate taxation, international transfer pricing (Chapter 19), global investment strategies (Chapter 12), and the evaluation of the performance of foreign operations and the managers of those operations (Chapters 18 and 19).
Required How is the move from GAAP to IFRS likely to affect the development of compensation plans in U.S.-based firms

Question 47

Business Analysis Brooks Plumbing Products, Inc. (BPP) manufactures plumbing fixtures and other home improvement products that are sold in Home Depot and Walmart as well as hardware stores. BPP has a solid reputation for providing value products, good quality, and a good price. The company has been approached by an investment banking firm representing a third company, Garden Specialties Inc. (GSI), that is interested in acquiring BPP. The acquiring firm (GSI) is a retailer of garden supplies; it sees the potential synergies of the combined firm and is willing to pay BPP shareholders $38 cash per share for their stock, which is greater than the current stock price; the stock has traded at about $35 in recent months. Summary financial information about BPP follows.
Required Evaluate BPP as a company using financial ratio analysis. Since the calculation of some ratios requires the averaging of balances, you may assume that the balances in 2011 are the same as those in 2012.

Question 48

Sticky Fingers Inc. produces scotch tape and masking tape. Last year's annual report has been compiled, and you are in charge of business analysis for the year. The company had a goal for inventory turnover of 6, cost of goods sold of $400,000, beginning inventory of $50,000, and ending inventory of $70,000. What was the actual inventory turnover, and at what percent did the firm achieve its goal

Question 49

Business Analysis Williams Company is a manufacturer of auto parts having the following financial statements for 2012-2013.

Required Calculate and interpret the financial ratios (per Exhibit 20.9 ) for Williams for 2012 and 2013. Since the calculation of many ratios requires the average balance in an account (e.g., average receivables is required in calculating receivables turnover), you may assume that the balances in these accounts in 2012 are the same as those in 2011.
Reference:

Question 50

Business Valuation Refer to the information in Problem 20-47.
Required
1. Develop a business valuation for 2013 using the market value method, the book value method, and the multiples-based methods.
2. Determine an estimated value for BPP using the discounted free cash flow method, assuming that the 2013 amount of free cash flow continues indefinitely.
3. Which of the methods would you use and why
4. Is the GSI offer a good one Why or why not
5. What would be the effect of sustainability issues, if any, in the acquisition BPP by GSI
Reference:
Business Analysis Brooks Plumbing Products, Inc. (BPP) manufactures plumbing fixtures and other home improvement products that are sold in Home Depot and Walmart as well as hardware stores. BPP has a solid reputation for providing value products, good quality, and a good price. The company has been approached by an investment banking firm representing a third company, Garden Specialties Inc. (GSI), that is interested in acquiring BPP. The acquiring firm (GSI) is a retailer of garden supplies; it sees the potential synergies of the combined firm and is willing to pay BPP shareholders $38 cash per share for their stock, which is greater than the current stock price; the stock has traded at about $35 in recent months. Summary financial information about BPP follows.
Required Evaluate BPP as a company using financial ratio analysis. Since the calculation of some ratios requires the averaging of balances, you may assume that the balances in 2011 are the same as those in 2012.